September 4, 2017 7:00 AM / BMI Research
BMI View: Despite concerns raised in the media that the Nigerian banking sector is looking close to a repeat of the 2009 banking crisis which saw non-performing loans top 33%, we hold a more positive view. Rising oil receipts and greater liquidity in the economy following the introduction of a new, tradeable, exchange rate in April, will see the economy, and the banking sector, improve.
The outlook for the Nigerian banking sector is fairly positive almost mid-way through 2017, and while we acknowledge risks, we expect the systemically important top five banks, which together account for over half of total banking sector assets, are financially sound and will remain so through the course of 2018.
There are greater concerns over smaller banks, where capital adequacy ratios (CARs) are being tested, especially when rising non-performing loans (NPLs) are taken into account. Further, profits will be lower compared to 2016, when most banks performed well.
Nevertheless, with rising oil prices and production, and diminishing liquidity constraints, we are confident the Nigerian banking sector will remain stable. We are positive towards the growth prospects for Nigerian banks in 2017 and beyond, although profit growth is unlikely to match that seen in 2016, despite the ameliorating outlook for the Nigerian economy.
Barring First Bank, the five largest banks in Nigeria saw sizeable gains in their profits in 2016 as they took advantage of a devaluation of the official naira exchange rate in June in order to implement profitable revaluations. In 2017, we no longer expect that there will be a devaluation to the official naira exchange rate (see 'NGN: Official Rate Staying Put, But Spread With Parallel Market Will Remain', May 4), which will preclude the banks from deploying such tactics again.
Nevertheless, we do expect that the new exchange rate policy being implemented will see a general uptick in the Nigerian economy, which will drive positive profit growth for most banks. Although the Central Bank of Nigeria (CBN) has not implemented a free float of the naira, preferring to operate a host of different exchange rates and making dollars available for different sectors of the economy at different rates, it has introduced a new tradeable exchange rate window for investors and traders.
We expect that this will boost economic activity in Nigeria by easing liquidity constraints present through 2016. Greater inflows of oil receipts, on the back of both higher prices and greater production, will also help in this regard. The greater liquidity in the economy will see increased activity in the banking sector.
This was already playing out before the Investors and Traders Window was introduced on April 24, with Segun Ajibola, president of the Chartered Institute of Bankers of Nigeria, telling Bloomberg on April 21 that they saw 'an improvement in the number of letters of credit, bills being settled and remittances being allowed.
With the new tradeable window now active, this trend will increase. Our optimism regarding the Nigerian economy and banking sector following the improvement in liquidity has been underscored by the performance of the Nigerian All Share Index, which has rallied since the new exchange rate was introduced. The banking sector has been performing strongly this year: the 21 banks, which make up 26.3% of market weighting, have climbed 22.8% year-to-date on May 18.
Risks Will Be Manageable
Even so, we note that there are still risks in the Nigerian banking sector following the tumultuous two years the economy has undergone, not least from NPLs. These had climbed to 14% in December 2016, according to the CBN. We do not expect that they will rise significantly higher than this, given the improvement in the economy this year, anticipating a level of around 16% before they begin to fall.
However, the picture is mixed between different banks, with some of the smaller and mid-tier banks having higher levels than the more sound top five where NPLs are as low as 3%.
These NPLs threaten CARs in the smaller banks, and a stress test by the CBN in April found that seven deposit money banks had CARs lower than the required threshold of 10% to 15%, depending on size, although a series of banks then came out publicly to state that they were stable. Given that the economy is improving, and it is only the smaller banks which seemingly have any issues, we are confident that the banking sector will remain resilient in 2017, and that a repeat of the 2009 crisis is off the cards.
The CBN put in a series of measures regarding capital ratios following the banking crisis, which makes the sector far more stable than it was previously. However, another shock to the oil sector in the form of further pipeline attacks or structurally lower prices would notably increase these risks.
Structural Characteristics Of the Banking Sector
The Nigerian banking sector is well regulated following a series of new legislation introduced in the wake of the 2009 crisis. As such, we view Nigerian banking as broadly stable over the coming years, despite the challenging headwinds buffeting the sector at present. Increasing penetration within the unbanked and the rise of mobile banking offer some tailwinds to growth.
Despite our expectation for a deterioration in asset quality in the coming months, we do not envisage a major crisis in the sector. The banks have, for the most part, manageable (albeit rising) levels of non-performing loans (NPLs) and healthy capital adequacy ratios (CARs). At Zenith, one of the country's largest banks, the CAR was at 19.0% in October 2016.
Similarly, FirstBank's CAR is at 18.9%, well above the 10.0% mandated by the CBN for banks of that size. Given that about one-quarter of total loans are concentrated in the oil sector, we expect NPLs will continue to rise in 2017, but contend they will remain manageable. All sectors are vulnerable given the general macroeconomic malaise, but oil in particular will be a source of stress. In H217, as the economy improves, and oil prices and production pick up, we expect NPLs will begin to fall once more.
Nigeria is one of the largest importers of dollars in the world. Dollarisation grew from 15% of deposits in 2011 to 23% by 2014 as the dollar has been used as a medium of exchange or currency substitution and as store of value or asset substitute. CBN directives on dollarization have been focused on the dollar being used for transactions or as a medium of exchange. About 45% of total loans are denominated in foreign currency.
CBN macro-prudential guidelines are focused on limiting foreign currency exposure by banks, including limiting foreign currency borrowing from 200% to 75% of shareholders' funds, and banning the issuing of invoices in dollars for domestic services. Most banks have FX hedge positions, which will protect them from the negative effects of the rapid naira depreciation in 2016.
Sovereign Support Capacity
In the past, the CBN has shown high levels of willingness and ability to extend emergency lines of credit to banks, suggesting a robust sovereign backstop for the industry. In 2008-2009, the global economic crisis triggered a banking crisis in Nigeria and the CBN took forceful measures to support the industry, injecting NGN620bn of liquidity, putting out a blanket guarantee on deposits and foreign credit lines and replacing management in eight banks. The Asset Management Corporation of Nigeria (AMCON) was established as a vehicle to purchase NPLs from banks.
However, the Nigerian government and the CBN have increasingly limited capacity to support lenders in the event of a financial crisis. The fall in the oil price has squeezed government revenues, leading Nigeria's fiscal deficit to expand – from 1.2% of GDP in 2014, to 2.0% in 2015 and 3.0% in 2016 – and reserves have been falling. In September 2014, AMCON announced it was no longer purchasing NPLs from banks.
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